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Pound plummets – markets, manias and viruses

George Trefgarne looks at hysteria in today’s market and tells us three things that may indicate when markets will begin to rise again.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please
seek advice. If you choose to invest the value of your investment will rise and fall, so you could get
back less than you put in.

George Trefgarne

19 March 2020

At the time of writing, the pound is at a 35-year low, of around $1.17, leaving the UK right in the firing line of
global investor panic. Many of us are asking ourselves when the market downturn will end.

International investors are concerned that the UK is vulnerable because it has historically had a large current
account deficit. In other words, we tend to import more than we sell abroad and are reliant on foreign investment in
UK assets to balance the books.

In actual fact, that’s slightly unfair, the current account deficit recovered dramatically from 6.8% to 2.8% of GDP
in the third quarter of 2019, the latest period for which figures are available.

Are investors being irrational?

From their individual perspective, maybe not. For instance, some institutions with high debts may be liquidating
positions at the behest of regulators.

There are many books on psychology and markets. The financial analysts can produce as many detailed models as they
like, but none of them can perfectly account for the herd behaviour of groups of investors and of societies in
general.

Charles Kindleberger explained in his classic book Manias, Panics and Crashes, that markets go through cycles,
including euphoria and panic, optimism and despair, boom and bust. The bottom only comes when the capitulation phase
yields to despair. This is where the last optimistic investors give up, believing prices will never recover.

Another economist called Hyman Minsky is famous for decreeing that instability is a fundamental feature of markets
and of the business cycle and this can be made worse by companies taking on too much debt. What is known as a
“Minsky Moment” occurs when a sudden loss of confidence causes sentiment to turn, triggering a dramatic fall in
asset prices. March 2020 may indeed be such a moment.

What this means now

With the coronavirus crisis, emotions may be running even higher thanks to social media and the internet. The World
Health Organisation has called the coronavirus crisis the first “infodemic” as information, some of it accurate,
some of it nonsense, proliferates online.

Evidence of the impact of the media in amplifying the current crisis is highlighted in a new academic paper. It has
found that panicky Google searches (which have historically indicated an upcoming contraction in economic activity),
relating to stock market crashes, recessions, conspiracy theories and survivalism have multiplied in infected
countries, rising by some 20-50%.

Misinformation obviously doesn’t help sentiment. For instance, in their new paper, "Perceptions of coronavirus
Mortality and Contagiousness Weaken Economic Sentiment," academics Thiemo Fetzer, Lukas Hensel, Johannes Hermle,
Christopher Roth, found that while there is no empirical evidence that the covid-19 virus mortality rate is higher
than 5%, more than 50% of Americans believe it is higher than that. They also believe it is more contagious than it
is. This is just one example.

The economic impact of hysteria can be severe. The academics argue that analysis of recent data suggests that,
having controlled for other variables, a 100% increase in search intensity for recession-related topics is
associated with a 1.6 % point lower consumption growth rate and a 1% point lower GDP growth rate in the following
quarter.

"We are naturally concerned that the gradual erosion of trust in institutions and particularly the media in the West
in recent years may exacerbate the panic reactions that are becoming visible," says Dr. Lukas Hensel of the
Blavatnik School of Government at the University of Oxford.

How will we know when the current crisis is abating and starting to turn?

History suggests there are three things to look for.

The first is a genuine widespread fear taking hold in markets.

The second is truly massive action by governments to turn the situation round. In this regard, the fact that the
British Government is not sitting still, but strengthening and deepening its actions on a daily basis, are grounds
for hope .

Investors may or may not be right that the British authorities have taken a too “laissez-faire” attitude to the
crisis. But they are certainly wrong to think they are not moving rapidly to take new actions every day. They may
also be underestimating not only the willingness of the Treasury and the Bank of England to inject money into the
economy, but the ability of the private sector and universities to supplement the efforts of the NHS in tackling the
crisis.

The third indicator that the bottom of a market has come is frequently significant corporate failures. In 2008, the
bankruptcies of RBS and then Lehman Brothers marked the low point. We haven’t seen that yet and there is undoubtedly
fear about what may happen in the airline, transport and hospitality sectors.

It goes without saying that calling a market bottom is incredibly difficult and something that not even experts get
right. Far better to take a longer term view and keep investing over time.

As the old saying goes, time in the market beats timing the market, nearly every time.

This article is not personal advice. If unsure, seek advice.

George Trefgarne is CEO of Boscobel & Partners, a political consultancy.

Hargreaves Lansdown may not share the views of the author.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek
advice. If you choose to invest the value of your investment will rise and fall, so you could get back
less than you put in.

Our analysts take a look at which share sectors are faring better than others in the current crisis.

Equity Research Team

23 Apr 2020 | 8 min read

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